When selecting stocks in the utility sector, most investors are looking to invest in companies that are "good." The criteria investors usually review is financial stuff like dividend yield, dividend growth, earnings and PE ratios, and Return on Invested Capital. However, "good" is a very subjective concept.
When discussing services and manufactured items, "good" usually implies a level of quality, such as, this is a really good toaster oven or that is a really good cup of Joe. Customer satisfaction surveys are an evaluation tool many use to understand the level of quality of a firm's goods or services.
How do the companies representing your utility investments rank in generating customer satisfaction?
Did you know there is a correlation between excelling in utility customer satisfaction and generating higher shareholder profits along with the potential for higher regulated rate increases?
Utility Customer Satisfaction Survey
J.D. Power and Associates have conducted customer satisfaction surveys for many years. Last May, they issued a report titled, "2012 Electric Utility Customer Satisfaction Survey." The methodology:
The 2012 Electric Utility Residential Customer Satisfaction Study is based on responses from more than 100,000 online interviews conducted from July 2011 through May 2012 among residential customers of the 126 largest electric utility brands across the United States, which collectively represent nearly 94 million households. J.D. Power measures overall customer satisfaction by examining six factors: power quality and reliability; price; billing and payment; corporate citizenship; communications; and customer service.
The ratings system generates a number for each firm from 100 to 1,000 with 100 being low and 1000 being high. The study lists the results for both publicly traded investor-owned and privately owned/municipal firms by size (large and mid-sized) and by region. Many of the local utilities are subsidiaries of larger utility holding companies.
Of the top 24 utilities in customer satisfaction, 12 are investor-owned or subsidiaries of investor-owned firms: PPL Corp (NYSE:PPL), Pepco (NYSE:POM), Exelon (NYSE:EXC), Public Service Enterprise (NYSE:PEG), Iberdrola, S.A (OTCPK:IBDRY), Berkshire Hathaway (NYSE:BRK.B), Alliant Energy (NYSE:LNT), Wisconsin Energy(NYSE:WEC), Integrys Energy (NYSE:TEG), NextEra (NYSE:NEE), and Portland General (NYSE:POR).
Below is a listing of the top three electric utilities in customer satisfaction by category and either a notation they are private/municipal or the stock symbol of the parent company:
East Region - Large
East Region - Midsize
S. Maryland Co-op
Midwest Region - Large
Midwest Region - Midsize
Omaha Public Power
Wisconsin Public Service
South Region - Large
South Region - Midsize
West Region - Large
West Region - Midsize
Clark Public Utilities
Seattle City Light
Colorado Springs Utility
Overall, customer satisfaction with electric utilities declined for a second-straight year. The average score of 625 for 2012 was down from 628 last year.
Correlation of Utility Customer Satisfaction and Return on Equity (ROE)
Requesting utility rate increases is much like asking your father for a raise in your allowance - you almost always get less than you ask for. However, if you had been "good" the chances are you should fare better than had you not been "good."
It seems there is a correlation between providing "good" customer service and achieving favorable regulated rate increases. As both JD Power and Standard & Poor's are owned by McGraw Hill (MHP), it would seem appropriate they would collaborate on a study comparing customer satisfaction and regulated utility ROE.
The study titled, "How Customer Satisfaction Drives Return on Equity for Regulated Electric Utilities" is pretty revealing in that it found state utility regulatory commissions decided rate request cases more favorably for those firms with higher customer satisfaction numbers. The more positive rate decisions created an environment for the electric utilities to generate higher ROE for shareholders.
A significant positive relationship was found between customer satisfaction and subsequent ROE one year later, such that a 10-point improvement in the overall satisfaction index score yielded a .04% increase in ROE (R2 = .37). In dollar amounts, if a utility were requesting a rate change on an equity base of $1 billion, it would equate to an increase of $400,000 for every 10-point increase in the overall satisfaction index score. Moreover, when utilities in the top quartile were compared to those in the bottom quartile, an ROE difference of .5% was found. Again, that translates to $5 million more per rate case for the top-quartile vs. bottom-quartile utilities (assuming an equity base of $1 billion).
Interestingly, a slightly stronger influence was also observed in the index score two years earlier. This suggests that it is the recent history of satisfaction, not just the most recent value, which influences the approved ROE.
Additionally, findings show that utilities with the highest proportions of highly satisfied customers (i.e., top quartile) received rate increases closer to their requests than did utilities in the bottom quartile. When measured in absolute terms, the average utility in the bottom quartile received an approved rate increase $74 million below the original request, whereas top quartile utilities received an approved rate increase $50 million less than initially requested.
While customer satisfaction surveys won't take the place of dividend growth and payout ratios in fundamental analysis of regulated electric utilities, it could be included in the decision-making process. In the case of two utilities with similar fundamentals, possibly comparing how well each firm excels in customer satisfaction may tip the scales.
Author's Note: See important disclaimer in Mr. Parepoynt's profile
Disclosure: I am long EXC, BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.